On the Trans-Atlantic Price Gap

This morning Eurostat, the European statistical agency, announced its “flash” estimate of November inflation for the euro area. It came in well above expectations — a 4.9 percent rise in prices over the past year. Still, this was lower than U.S. inflation: In October our consumer prices were up 6.2 percent over the year. And technical differences appear to downplay the U.S.-Europe difference. If we use a European-style index to calculate U.S. inflation over the past year, it was 7.3 percent.

Now, one-year inflation is a problematic measure right now, because many prices were temporarily depressed by the pandemic. Many commentators like to focus on price rises over two years to avoid this problem. When you do, however, the difference between the United States and Europe remains striking:

Does lower (although still high) inflation in Europe tell us something about inflation here? A number of commentators have argued that the difference shows that deficit spending, which has been bigger in the United States, is a major cause of inflation. For example, Jason Furman, the former head of President Barack Obama’s National Economic Council, has put the Europe-U.S. differential at the core of his argument that the American Rescue Plan bears a lot of responsibility for current inflation:

He could be right. But I’ve been arguing that the case for deficit-driven inflation is weaker than it might first appear — that the details of the U.S. story don’t fit the narrative. What about the details of the argument based on trans-Atlantic inflation differences?

Well, I see two and a half problems with emphasizing Europe’s relatively low inflation. The half problem is that the story may change: The data released this morning offer at least a hint that Europe’s inflation is starting to catch up with America’s.

A bigger problem is that the trans-Atlantic difference in fiscal policy isn’t as large as many people assert. You don’t want to simply compare budget deficits; the United States came into the pandemic with much larger deficits than Europe, and what should matter is the change in the deficit — or more specifically the change in the “structural” deficit, that is, adjusted to correct for economic factors not related to policy. And there the difference between America and the euro area is a lot less striking — around six points of stimulus versus four:

Another problem is the issue I emphasized in yesterday’s column: Fiscal policy is by no means the only difference between the United States and Europe. Another key difference is that European employment policy appears to have been much more successful than ours at keeping workers connected to the job market. There is no European equivalent of the U.S. Great Resignation: Workers there have more or less fully returned to the labor force, even as many Americans stay on the sidelines:

As a result, Europe is suffering less from labor shortages, and hence from bottlenecks that drive up inflation, than we are.

Maybe the most important point, however, is that the question of what caused current inflation isn’t actually the question we want answered. What we want to know instead is what happens next, and even more important what we should do next. The fiscal expansion of early 2021 is receding in the rearview mirror. Will inflation also recede? Or do the Federal Reserve and the European Central Bank need to raise interest rates to cool off the economies they oversee?

I don’t think the answer to either of those questions is clear yet, especially with the Omicron variant of the coronavirus adding a new layer of uncertainty. As I write this, the price of oil is down about 20 percent from its level earlier this month; how will people feel about inflation if gasoline prices fall, say, 40 cents a gallon?

Still, I applaud the effort to use U.S.-Europe differences as a tool for understanding where we are and where we’re going.

Quick Hits

Bond markets are on Team Transitory.

Data.

The case for patience.

Consumer sentiment is wildly partisan.

Facing the Music

R.I.P. Stephen Sondheim. My parents took me to see “A Funny Thing Happened on the Way to the Forum” when I was around 10. I was grumpy, thinking that they were dragging me to a boring adult thing. A few seconds into the opening number I was grinning from ear to ear.